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Executives

Cathy Taylor – Director, IR

Anil Singhal – Founder, President, Chairman and CEO

Michael Szabados – COO

David Sommers – CFO and SVP, General Operations

Analysts

Alex Kurtz – Merriman and Company

Mark Kelleher – Brigantine Advisors

Scott Zeller – Needham and Company

Ryan Bergan – Craig-Hallum

Gary Spivak [ph] – Noble Financial

Rohit Chopra – Wedbush Securities

NetScout Systems, Inc. (NTCT) F4Q10 (Qtr End 03/31/10) Earnings Call Transcript April 29, 2009 4:30 PM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to NetScout's fourth quarter and fiscal year end 2010 operating results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given to you at that time. As a reminder, this conference call is being recorded. With us today is NetScout's President and CEO, Mr. Anil Singhal. He's accompanied by NetScout's Chief Financial Officer, Mr. David Sommers and NetScout's Chief Operating Officer, Mr. Michael Szabados. Also with Mr. Singhal is NetScout's Director of Investor Relations, Ms. Cathy Taylor. At this time, I will turn the call over to Ms. Taylor to provide the opening remarks. Ms. Taylor, please proceed.

Cathy Taylor

Thank you, and good afternoon, everyone. Welcome to NetScout's fourth quarter and fiscal year end 2010 conference call for the period ended March 31st. Before we begin, however, let me remind you that during the course of this conference call, we will be providing you with the discussion of the factors we currently anticipate that may influence our results going forward. Such statements are forward-looking statements made pursuant to the Safe Harbor provisions of Section 21(e) of the Securities Exchange Act of 1934 and other Federal securities laws.

These forward-looking statements may involve judgment and individual judgments may vary. Forward-looking statements include expressed or implied statements regarding future economic and market conditions, our guidance for fiscal year 2011 and our new product releases. It should be clearly understood that the projections on which we base our guidance and other forward-looking statements and our perception of the factors influencing those projections, are highly likely to change over time.

Although those projections and the factors influencing them will likely change, we will not necessarily inform you when they do. Our company policy is to provide guidance only at certain points in the year, such as during the quarterly earnings call. We do not plan to update that guidance otherwise. Actual results may differ materially from what we say today and no one should assume later in the quarter that the comments we make today are still valid. For the further discussion of the risks and uncertainties that could cause our actual results to differ, see the specific risks and uncertainties discussed in NetScout's annual report on Form 10-K, for the year ended March 31, 2009 and subsequent quarterly reports on form 10-Q on file with the Securities and Exchange Commission.

Also, in our discussion, non-GAAP revenue excludes the effect of purchase accounting adjustments, representing the reduction to fair value of Network General's deferred revenue and non-GAAP net income excludes share-based compensation expenses, amortization of acquired intangible assets, cost and expense of various acquisition-related items and related income tax adjustments. I will now turn the call over to Anil Singhal, our Chief Executive Officer.

Anil Singhal

Thank you, Cathy. Today we are reporting our fourth quarter and 2010 fiscal year end results. We are very pleased with our financial performance throughout the year and especially in a difficult economy. We set a record for bookings and deferred revenue and our fourth quarter results were consistent with the pre-announcement earlier this month.

For the fiscal year, we achieved a full-year revenue on earnings guidance that we issued back in April 2009. Our guidance a year ago was based on the expectation that we would accelerate bookings and revenue significantly in the second half. We did what we said we would do in Q3 and then again in Q4, where we saw revenue up sequentially and also year-over-year.

Fourth quarter GAAP revenue was $71.9 million and non-GAAP revenue was $72 million. For the fiscal year ending – ended March 31, GAAP revenue was $260.3 million and non-GAAP revenue was $261.7 million. Our revenue results in the second half of this past year were driven by seasonally strong bookings, augmented by secular growth in several areas. Full-year bookings were up 12% year-over-year, demonstrating the strength of our market position, technology and products.

We expect our second half momentum to continue into the current fiscal year, driven primarily by the high growth wireless service provider sector and returning strength in the financial services sector. And David will later provide the details of our fiscal 2011 outlook in a few moments. Even though GAAP revenue was down 3% for last fiscal year and non-GAAP revenue was down 6%, we met our goal of expanding operating margins and improved operating efficiency.

As a result, fiscal year 2010 GAAP operating margin was 18%, up from 14% in fiscal 2009 and non-GAAP operating margin was fractionally higher at 22%. GAAP net income for the quarter was $7.1 million, with earnings per diluted share of $0.17. Non-GAAP net income was $9.1 million, with earnings per diluted share of $0.22.

For the fiscal year, GAAP net income was $27.9 million or net income per diluted share of $0.67. Non-GAAP net income was $35.9 million or $0.86 per diluted share. In addition to record bookings during the year, deferred revenue was up $22 million, as we saw our satisfied customers making large commitments in maintenance of its contracts.

We also achieved a record high of cash and marketable securities, with $171 million, increasing $35 million year-over-year and up $19 million in the quarter. All of these results are driven by a fundamental commitment to develop innovative technologies and market leading products that will expand our market reach, while solving the challenges facing IT managers in such area as virtualization, wireless networks and cloud computing.

During the year, we launched some significant new products and a broadening of an impact across the enterprise, government and financial services sectors. We remain focused on gaining market share in the very fast moving wireless service provider market. We released an important new product, Subscriber Intelligence with more products on the roadmap for our service provider customer.

As we have been building our product line, we have also been working on developing a new patent-pending technology that we believe will revolutionize the functionality and performance of our solution suite. This technology, the new method of measuring network traffic and exposing the end-user experience that's important to the new computing environment, where network management is moving towards a service management is moving towards a service management discipline.

As applications become more complex and critical and traffic is growing – growing exponentially, IT departments are increasingly being asked to manage a network, its component and related applications as services. Our new technology has the ability to explore the information that is in the – hidden in the details of the packet flow that today often requires an expert to de-code in such a way that it can create a snapshot of application sessions that are mapped to user sessions. These snapshots that we call AST, or adaptive session traces will reduce the massive amount of first-line packet data, which is necessary for today's analysis, without compromising granularity.

They will accelerate packet de-coding and deliver information that will meet the increasing demands of very high speed, multi-10 gig up to 10 gigabytes per second network technologies. The new technology will provide faster, deeper, real time and historical analysis, fast data access in order of magnitude or more data deduction.

We believe this new technology will enable new areas of monitoring mission-critical business applications while capturing business intelligence and the end-user experience that will help expand our footprint in the enterprise and the growing wireless service provider space. We'll be phasing in this technology over the next 12 to 18 months in smooth transition for our customers.

Looking into the next physical year, we are very excited about the opportunities ahead of us that we believe will position NetScout as the leading provider of end-to-end, unified service delivery management, as it becomes critical to our customers across all of our vertical markets.

As always, I would like to thank all of our employees, customers, investors and other stakeholders for their continued support. We look forward to sharing our accomplishments with you throughout the coming year. Starting with this quarter, Michael Szabados will be joining me and David as a speaker during our quarterly conference calls. I will continue to cover the reserves and growth strategy and David will continue to provide the detail in financials and guidance. Michael will bridge the gap between the two by providing additional color on the building blocks of our success and related operations details. I will now turn the call over to Michael.

Michael Szabados

Thank you, Anil. As Anil mentioned, we are working on a number of key initiatives that will provide us a platform for expansion into fiscal year 2011. The service provider segment is a key growth vertical for us and last year we saw our service provider bookings grow more than 40%. We are intensifying our focus on this segment to ensure our continued technology leadership with new products supported by additional engineering resources and a realigned sales force.

Our product features are suited to provide service assurance to large mobile carriers coping with exponentially increasing IP traffic, with a growing number of large carriers, where we are the principal monitoring and troubleshooting solution for IP data services. We are becoming instrumental in the carrier's transition from legacy networks to 3G and 3.5G technology.

The transition from 3G to 4G LTE or long-term evolution is just beginning and is in the pilot phase in key tier one providers. In the coming months, we will be launching a new product with increased speed, storage and functionality for these new platforms. We released our new nGenius Subscriber Intelligence product late last year and have continued to win service provider customers globally as our recent MTN press release demonstrates.

We now have dedicated vertical sales coverage of tier one accounts and we are expanding our tier two account presence, especially in North America. We are also expanding our sales force globally, enlarging our sales footprint in Europe, the Middle East and Asia. In the financial services vertical, we are beginning to see growth again. Q4 bookings nearly doubled year-over-year and full-year 2010 bookings grew at the mid-teens percentage rate.

We are expanding our product functionality in high-speed trading, a new product targeted at micro-second-level trade latency monitoring applications. We are also intensifying our financial vertical sales focus globally. Our federal government sector performed well, with fiscal year 2010 bookings percentage growth in the high teens.

Here we have been expanding beyond our traditional agency business, with more dedicated sales and marketing resources focused on the system integrity through a channel. We are beginning to see some growth in selected verticals within the general enterprise vertical.

In the enterprise, we are expanding our footprint from the data center with our new product, the nGenius Virtual Agent, out to the branch office with our host of software agent family, the first of which is the newly released Cisco integrated agent running on Cisco's integrated services routers, ISRs. I'd like to put some perspective around our expanding partnership with Cisco at this point.

We are currently working with Cisco in multiple areas, which develops the wireless LAN, unified communications and voice over IP initiatives. The new integrated agent developed in cooperation with Cisco for Cisco's new borderless networks initiative, can run on potentially millions of installed Cisco ISRs or integrated services routers.

We are demonstrating it as we speak with Cisco at Interrupt [ph] and again at Cisco Live in June, and over 10 marquis customers. We have also enhanced our relationship with HP, expanding the implementations of our successful product implementation with HP's network node manager or NNMI, with HP customers and developing a newly – resale relationship with HP Enterprise Services, the former EDS, that is already bearing fruit for both of us.

And we have built a new relationship with VMware, with our nGenius Virtual Agent, which we expect to be the platform upon which we can build an expanding collaboration. In order to realize our growing market opportunity, we are in the process of increasing our investment in R&D and sales and marketing. We believe this will be a key to gaining market share in the recovery.

We will continue to invest aggressively into our exciting growth opportunities, but prudently enough to continue to expend profit margins and cash flow as we move into fiscal year 2011. I would like to now turn the call over to David.

David Sommers

Thank you, Michael. Our quarterly results are in our earnings press release financial statements. We report our results on a GAAP basis, as well as a non-GAAP basis. Our non-GAAP results eliminate the GAAP purchase accounting effects of the acquisition of Network General by adding back revenue related to deferred revenue revaluation and removing the cost and expense of various acquisition-related items.

In addition, we remove the GAAP effects of stock-based compensation. I will give you the specifics about the differences between GAAP and non-GAAP as I discuss our results. These differences are disclosed in a reconciliation table in the financial tables attached to the press release.

We believe these adjusted financial measures will enhance your overall understanding of our current financial performance and our prospects for the future. We use these adjusted financial measures internally for the purpose of analyzing, managing and forecasting our business.

For the fourth quarter, GAAP revenue was $71.9 million, non-GAAP revenue of $72 million even. Our non-GAAP revenue excludes $112,000 purchase accounting adjustment to reduce to fair value the acquired Network General deferred revenue.

Product revenue on a GAAP and non-GAAP basis was $42.3 million. Both GAAP and non-GAAP were up 15% over year and both were up 4% sequentially. Service revenue on a GAAP basis was $29.6 million, up 1% over – year-over-year and down 1% sequentially. Non-GAAP service revenue was $29.7 million, down 1% year-over-year, and down 2% sequentially. Our GAAP gross profit for the quarter was $56.3 million, GAAP gross margin was 78% in the quarter.

On a non-GAAP basis, gross profit was $57.5 million and gross margin was 80%. We made the following adjustments to non-GAAP gross profit. $112,000 was added back from revenue. We removed $119,000 of share-based compensation expense, and $995,000 of amortization of acquired intangible asset expenses. Both GAAP and non-GAAP gross margin were comparable to last quarter.

Gross margin remains strong due to the continued cost improvement and improving product mix. GAAP income from operations was $11.5 million. GAAP operating margin was 16%. GAAP net income for the quarter was $7.1 million, yielding earnings per diluted share of $0.17 and GAAP net after tax margin was 10%.

Non-GAAP income from operations was $14.9 million and operating margin was 21%, several points below our target operating margin range. The following items, totaling $3.4 million, are adjustments to arrive at non-GAAP operating income.

The purchase accounting adjustment to reduce to fair value of the acquired network general deferred revenue of $112,000 was added back to GAAP. Amortization of acquired intangible assets of $1.6 million, which was principally from the Network General acquisition was removed from GAAP cost and expense. Share-based compensation expense of $1.7 million was removed from GAAP expenses.

Non-GAAP net income was $9.1 million or $0.22 per diluted share. Non-GAAP net after tax margin was 13%. We've used the statutory tax rate of 38% to tax-effect the $3.4 million total non-GAAP adjustment amount, adding $1.3 million to GAAP tax expense. The non-GAAP adjustments to our GAAP results are summarized in the reconciliation table included with our press release.

Provision for income taxes as recorded on a full-year effective tax rate of 35% on a GAAP basis and 36% on a non-GAAP basis. Our current long-term model remains as follows. Non-GAAP gross margin is 78% to 81%, R&D expense to revenue 13% to 15%, sales and marketing expense to revenue 33% to 35%, and G&A expense to revenue 6% to 8%, yielding an operating margin range of 24% to 27%.

In the future, as we invest in driving revenue and return to sustainable expense levels, we expect that higher revenue levels will be required to achieve our target margin range. Looking back over the 2010 fiscal year, despite revenues down year-over-year, we achieved notable margin improvements.

We hit the full-year guidance that we gave in April 2009, although we missed our January EPS guidance, as we had pre-announced on the 13th. And that was due to high sales incentive expense, as we said, driven by high service provider and maintenance renewal bookings.

Full-year GAAP gross margin was 78%, up two points year-over-year. Non-GAAP gross margin was 80%, up one point compared to last year. Non-GAAP operating margin was 22.4%, up 0.5 a point, and 1.5 points below the low end of our target margin range. GAAP net margin was 11% compared to 7% in the prior year. GAAP EPS was $0.67. Non-GAAP net margin was 14%, up one point year-over-year and non-GAAP EPS was $0.86.

Our balance sheet strengthened significantly during the quarter. Cash in short and long-term marketable securities hit a record high of $170.6 million compared to $151.3 million as of the end of the prior quarter, up $19 million and up $35 million for the year. Long-term marketable securities include investments and auction rate securities valued at $28.5 million.

As of March 31, 2010, the value of these securities includes a temporary decline in value of $3.9 million below par to reflect liquidity concerns. All these investments have investment grade ratings ranging from AAA to A, with underlying support from the Federal Government through the Federal Family Education Loan Program.

We believe these securities have no credit issues, only short-term illiquidity. We have classified them as long-term on our balance sheet and recorded the temporary decline in value to accumulated other comprehensive loss on the balance sheet. With our strong cash position and positive cash flow, the illiquidity of these securities poses no liquidity problems for us.

Accounts receivable net of allowances was $65.6 million, up from $57.7 million last quarter. Day sales outstanding were 81 days for the quarter, based on GAAP and non-GAAP revenue and well above our typical DSO range of 45 to 55 days.

This is up from 75 days in the prior quarter based on GAAP revenue and 74 days – also 74 days using non-GAAP. The increase in DSO is due to high order flow at the end of the quarter, which included unusually high service content.

Service renewals are normally for 12 months, leading to revenue recognized ratably over that 12-month period. This quarter, we saw a record number of multi-year contracts from some of our largest customers who are reaffirming their confidence in our relationship, which delivers them ongoing new value from our development efforts on their behalf.

We also received a record high number of early renewals, which are orders for service period starting in fiscal 2011, near the end of the quarter, which drove DSO up further. We expect DSO to return to our normal range in fiscal 2011 and to drive even higher cash flow in fiscal – than in 2010, as it does so.

Inventories were $9.2 million, up from $8.7 million in the prior quarter. Inventory turns were 3.1 times. Turning to other metrics. Revenue contribution from direct customers was 39% and reseller revenue was 61%. Revenue from international sales was 31% of total, up from 30% last quarter.

Europe delivered 15%, down one point. Asia came in at 7%, up three points. Other international sales were 9%, down one point. We expect to continue our international sales expansion, as Michael outlined, driven by our growing investments in our service provider business outside North America.

Summarizing large deals that we booked in the quarter, 139 customers gave us orders over $100,000, up from 133 in the second – in the third quarter. 38 customers gave us orders over $500,000, up from 27. Included were 17 orders over $1 million, up from 13 in Q3.

Nine of the million dollar orders came from the telecommunications, or wireless sector, five came from financial services as that sector begins to rebound, two from government, and one from high-tech. As expected, this mix reflects our growing wireless service provider business and the return of financial services to robust buying patterns.

We saw bookings from the sectors as follows. The telecom, or wireless sector, was up, led – and led the way with our sector share of 31%. Financial services was a close second at 30% and government was 12%. The healthcare sector was 6 and high-tech followed with 5% of total bookings. Our telecommunications bookings this quarter included another significant win with the same major U.S. wireless carrier that topped our bookings in the December quarter.

Now, let me remind you of a change we're making in our revenue accounting policy beginning this fiscal year, 2011, that will begin to affect our revenue recognition in the second half of the fiscal year. We've concluded, along with many other technology companies, that we should early adopt ASC985, which was issued last September.

As we discussed last quarter, for most of our product sales, this will result in minimal change to revenue recognition. Our hardware products, like the InfiniStream, will fall under the new guidelines, but we anticipate that revenue impact will be slight. For our software and appliance software sales, we anticipate that the second – in the second half of fiscal 2011, we will begin ratable revenue recognition over the term of the maintenance period that is sold with the software.

This will result in slower revenue recognition of soft – slower recognition of software revenue than we would recognize under the current rules and, therefore, lower period revenue, particular during an initial phase-in period of four or more quarters. We will report to you revenue and earnings based on both methods of accounting during the phase-in period until ratable revenue recognition is fully established in our results.

As a result of this pending change, revenue will become somewhat less meaningful as an indicator of our underlying business performance. Therefore, we have started to disclose our quarterly bookings results, as well as backlog when it is material.

Bookings in Q4 were $86.3 million, up $26.3 million or 44% year-over-year. New business bookings were $56.1 million, up $19.8 million or 55%, while contract service renewal bookings were $30.2 million, up $6.5 million or 27% year-over-year.

Our service renewal total includes $4.8 million of bookings for service beyond a normal one-year contract period. Product backlog at the end of Q4 remained immaterial, all that increased – although it increased modestly from the third quarter.

Driven by the strong service bookings, deferred revenue grew to $102 million, up $22 million or 28% year-over-year. Bookings for the full fiscal year 2010 were $276 million, up $31 million or 12% year-over-year. And now to guidance. As I mentioned in fiscal year 2011, NetScout is adopting the new accounting standard within the scope of ASC985 for software revenue recognition.

Subsequently – consequently, we will be issuing guidance under the new accounting standard, as well as guidance under the prior standard for comparison with prior periods. Under the new standard, NetScout expects GAAP and non-GAAP revenue to be in the range of $278 million to $295 million.

GAAP net income per diluted share, under the new standard, is expected to be in the range of $0.72 to $0.81 and non-GAAP per net – net income per diluted share between $0.91 and $1 even. Under the former standard, NetScout expects GAAP and non-GAAP revenue will be in the range of $280 million to $297 million, growth of 7% to 14% year-over-year.

GAAP net income per diluted share will be in the range of $0.75 to $0.84, growth of 12% to 25%. Non-GAAP net income per diluted share will be between $0.94 and $1.03, growth of 9% to 20%. This version of guidance is the one that is comparable to our prior period results and as well to the preliminary projection that we gave you on April 13th.

Further to our guidance. We expect that the pattern of quarterly revenue results this year will mirror those of fiscal 2010, because we are entering this year, 2011, with a minimal level of backlog, just as we did in 2010. The consequence of that is that our revenue results will closely reflect our normal booking seasonality as they did last year.

At the EPS level, we expect a greater skew in quarterly results than last year. That is, a greater difference in the level of quarterly EPS between the first half of the year and the second half, than we saw in 2010, a greater difference than 2010. This is because of the front-end-loaded hiring in engineering and sales that Michael spoke about and that hiring will push almost all of the full-year EPS growth into the third and fourth quarters. That is, year-over-year growth will be primarily in the third and fourth quarters.

The fiscal year 2011 non-GAAP revenue expectation, before and after the accounting change, excludes the purchase accounting adjustment to fair value of approximately $100,000 of Network General's deferred revenue and non-GAAP net income per diluted share expectation excludes the deferred revenue purchase accounting adjustment, as well as share-based compensation expenses of approximately $6.9 million, amortization of acquired intangible assets of $5.9 million and the related impact of these adjustments on the provision of income taxes – for income taxes of $4.9 million.

That concludes our financial discussion this afternoon. Thank you for joining us for the prepared remarks. We look forward to taking your questions. Andrea, would you please go ahead.

Question-and-Answer Session

Operator

Thank you, Mr. Sommers. (Operator Instructions) We'll pause for a moment to compile the Q&A roster. Your first question comes from the line of Alex Kurtz with Merriman and Company. Your line is open.

Alex Kurtz – Merriman and Company

Hi. Thanks, guys, for taking the question.

David Sommers

Sure.

Alex Kurtz – Merriman and Company

So I didn't notice – I noticed that you guys didn't talk about the long-term growth and bookings in the high teens in the script today versus the last couple quarters. Is there a change there or is that still the expectation of what you guys can grow?

David Sommers

That's still our expectation. Based on our last conversations, Alex, I thought you were tired of hearing it, so we didn't include it.

Alex Kurtz – Merriman and Company

Never tired of hearing that. So in the spirit of moving towards bookings away from backlog, David, you want to save us the suspense? Can you give us the last three quarters up until the fourth quarter, the bookings, total bookings for the company, so we have a full picture of 2010?

David Sommers

We will do that. We'll pull that together. I don't have it right here at my fingertips. But let us get that and we'll give it to you a little later.

Alex Kurtz – Merriman and Company

Okay. And just the last question, Anil or David or Michael, what would it take – what kind of circumstances do you need to hit the high end of your revenue range, revenue growth targets? Thank you.

Anil Singhal

Well, it’s Anil. yes, basically we talked about we are counting on a pickup in enterprise spending, especially in the financial sector and which we started seeing already in Q4. But I think we already see improvement on the service provider side as we saw last year and the changes and the improvement continue in the economy, what we saw in Q4, then we have a good chance of hitting the high end of the range.

Alex Kurtz – Merriman and Company

Do you feel like from what you've seen so far in the March quarter and early April, that the trends would point to having greater confidence in the high-end of the range?

Anil Singhal

Well, we have received a lot of improvements and, as a result, yes, obviously, the confidence is there on the high end of the range. I think in the quarter or so, we'll know for sure how fast it's ticking up.

Alex Kurtz – Merriman and Company

Okay. Thank you.

David Sommers

I have the quarterly bookings, Alex.

Alex Kurtz – Merriman and Company

Okay.

David Sommers

Q1 50, Q2 52, Q3 87, Q4 86.

Alex Kurtz – Merriman and Company

Thank you, David.

David Sommers

Cross flip my numbers; make sure they're right.

Operator

Your next question comes from the line of Mark Kelleher with Brigantine Advisors. Your line is open.

Mark Kelleher – Brigantine Advisors

Great. Thanks for taking the question. I was just wondering, David, if you could help me connect a little bit the deferred revenue growth to the service revenue line. Deferred revenue's been jumping up nicely in the past quarter and the quarter before that had a nice jump as well but the service line has been fairly flat for the last seven quarters. Can we expect that to start moving up, or – and why wouldn't that increase in deferred revenue on the service line mitigate some of the seasonality for the June quarter?

David Sommers

Good question. Complex dynamics going on here. First of all, our – the underlying dynamics that go on to – that drive service revenue have more to do with our level of new product bookings and the addition of new inventory to our service inventory in the field with our customers than to the rate at which renewal contracts come in. In other words, as customers decommission old, old products, and that happens continually and take them off of service contracts, we need to replenish that inventory with new product bookings and therefore, new product eligible, service eligible products.

In Q4 of FY '09, Q1 and Q2 of FY '10, we had pretty low bookings, as we just laid out for Alex on Q1, Q2. And, therefore, that has put a damper on our service revenue. Now, deferred revenue, although clearly related, is affected by a different phenomenon in the short term. In the short-term, what we've seen is the multi-year contract renewals that we've talked about now for two quarters, which don't – which are very good for us, and early renewals which go into deferred revenue, which are also very good for us. But neither one of those affect the current revenue rate of the way – the rate at which revenue recognition comes off of the balance sheet. They have only to do with the commitment to future revenue.

So it's very good in that now we don't – we have this commitment for contract starts in FY '11 and in many cases, for longer term commitments, multi-year contracts. So that revenue now is more assured. But it's not happening any quicker than it would have if – in terms of revenue recognition, than it would have if we had gotten the contracts on a normal pace and for one year only. It's a complex subject. Was that clear enough?

Mark Kelleher – Brigantine Advisors

That was very helpful. I guess my next question would be, should we look for any growth in the service line or is that going to be stuck there around 29…?

David Sommers

No, you should look for growth. One of the things that we said to – we've said is bookings, product bookings – bookings, including product bookings, are growing now. If you recall, we pointed to new product – new business bookings up strongly in Q4, just as an example of that. So as new product bookings grow strongly, then you will see that drag service revenue. That's the best indicator of rising service revenue.

Mark Kelleher – Brigantine Advisors

Okay. Great. Thanks. That helps.

David Sommers

Thank you.

Operator

Your next question comes from the line of Scott Zeller with Needham and Company. Your line is open.

Scott Zeller – Needham and Company

Hi. Thanks. Regarding the commentary about the, I guess we'll call it the seasonality, first half versus second half of fiscal '11, could you give us a sense of what operating margins might look like first half versus second half?

David Sommers

Well, I can give you some idea. We will – we expect significant operating margin expansion in the second half, as revenue seasonality takes hold and flows down to profit. We've talked about, as Michael said, investing, but not so much that we won't grow operating margins in our guidance range. So you can expect full-year operating margins to grow modestly and you can expect most of that growth, as we talked about with EPS, to occur in the second half. So you should expect operating margins to be at or below levels of 2010 in the first half and to grow above 2010 levels in the second half.

Scott Zeller – Needham and Company

Okay. That's helpful. Thank you.

Operator

Your next question comes from the line of Ryan Bergan with Craig-Hallum. Your line is open.

Ryan Bergan – Craig-Hallum

Hi. Thanks. The top three verticals in the fourth quarter represent about 73% of bookings, that's up from about 70% in Q3. This seems to imply that the enterprise vertical is further weakened from Q3. Can you talk about the pipeline there and what actions you're taking to try to get the enterprise to come back? I mean, is it executional or are we continuing to see budgets that are still kind of frozen and they're not spending that money?

David Sommers

We have seen a lag as we have been talking about, in the return of our enterprise growth. We still expect it. We did this quarter, as Michael had indicated, see some early signs of that in growth from some of our leading enterprise sectors. Amongst them was health, healthcare, energy and surprisingly, perhaps, consumer. Those were some of our leading growth sectors for the year, for the year in terms of bookings in the general enterprise space. So we see signs that it's recovering.

Now, we've said, I think, in several calls during this downturn, that we typically experience lags versus other vendors of infrastructure and some other vendors of management solutions, because our projects, the nature of our customer relationships, most of our selling is done on a project basis and projects take 6, 9, 12 months. So on the way down, as downturns begin, we typically lag as projects get completed, that we're close to completion. And then, when the downturn starts back up again, similarly we lag as projects that are long way have to get started up. So we know that other players are seeing upturns in their enterprise business that we have not yet seen on a broad basis.

But we expect the enterprise business to be strong and some of the things that Anil talked about, the new technology that is not here now, not in the product line now, but will be over the 12 to 18-month time frame, are going to be targeted at the enterprise, as well as other markets and we think will help us improve significantly our competitiveness there. And there are other initiatives going on that Michael can, I think, comment on in fiscal '11 in the enterprise space.

Michael Szabados

Yes. Thank you, David. And some of this, I already pointed out in my prepared remarks. The virtualization initiative and the Virtual Agent product itself is a major forward-looking indication of strength. Another key element in the enterprise strategy is our significantly increasing and increasing momentum in the Cisco relationship. As I said before, we are just demonstrating a product jointly with Cisco at Interrupt [ph] today. And also, we have lined up a number of products in the general – to be released over the next 90 days, specifically in the general enterprise area, focused on service – on the service level and the service level visibility and also in terms of the financial segment separately. But the enterprise, in general, is going to receive a large push from a product standpoint and we messaged it very strongly at the recent sales meeting, as our next focus.

Ryan Bergan – Craig-Hallum

And then you had talked about a new, I guess product that was working with the rollout with 3G to 3.5G to 4G, that you expected in the coming months. Do you have kind of a target date for when this new product will be either released or going to be in data?

Michael Szabados

Well, it's already in for trials today and that product is going to be out before the end of the quarter.

Ryan Bergan – Craig-Hallum

Before the end of Q1?

Michael Szabados

Yes.

Ryan Bergan – Craig-Hallum

Okay. And then when do you – so with your 3G to 4G potential, when do you think you can expect to see booking events from 4G rollouts?

Michael Szabados

Well, we already have seen some first dollars coming in from that. But I think it's not going to really happen until fiscal year '12, in earnest. Maybe this year we're going to see a few million dollars in the (inaudible) 4G space but the spigot is going to be turned on in '12 and on.

David Sommers

Fiscal years.

Michael Szabados

Fiscal '12 and on.

Ryan Bergan – Craig-Hallum

Okay. And then you talked about how you're going to ramp up some – you're going to hire some people. How many people do you expect to hire and it sounds like you're going to do this within the next couple of quarters. How many people do you looking at…?

David Sommers

We're not…

Ryan Bergan – Craig-Hallum

…you expect to add?

David Sommers

I'm sorry, Ryan. We're not going to give specific hiring targets. Suffice it to say it's a significant up tick in engineering and sales for us, those are the revenue driving areas for us and we have already started. That hiring has begun in earnest in Q4, and was included in all the guidance that we'd given at the beginning of Q4 as well. So you will see – we will talk about it in broad terms as we do it, but we're not going to give specific numbers.

Ryan Bergan – Craig-Hallum

Okay. And then let me just finish with some just housekeeping, cash from ops, CapEx, depreciation, and current headcount, if you don't mind sharing that.

David Sommers

So depreciation for the quarter is $1.9 million, CapEx $2.0 million, cash from ops we'll get to you in just one second.

Ryan Bergan – Craig-Hallum

And then do you have headcount?

David Sommers

We do. Hold on. 791 bodies with heads.

Ryan Bergan – Craig-Hallum

And cash from ops number, that wraps it up for me.

David Sommers

It's coming. We'll have to break back into the next conversation, so stay tuned.

Ryan Bergan – Craig-Hallum

Very good. Thank you.

David Sommers

Thank you.

Operator

Your next question comes from the line of Gary Spivak [ph] with Noble Financial. Your line is open.

Gary Spivak – Noble Financial

Thank you. Thank you for taking the call. A couple of questions. One, the trend of the large multi-year renewals, as you sit from your vantage point today, do you see that continuing through the first half, let's say, or at least through fiscal '11?

David Sommers

No, we don't. We think it was, in large part, a phenomenon of the time, the recessionary times when customers were willing to commit to an extended service relationship, knowing the strength, the value of our solutions, strength of our relationship historically. But there's only so much of that that you can do with major customers. Once they've done a two or three-year renewal, it's not going to happen again for a while. So we don't expect that to continue as a major trend. We think it was an artifact of the times.

Gary Spivak – Noble Financial

Well, then do you risk seeing the flip side of that, that it could actually slow down?

David Sommers

Well, bookings will slow down, but that doesn't matter because we've already got the service contract that we don't need to book again, if that's clear.

Gary Spivak – Noble Financial

Got you. Okay. And then I wanted to ask about the new technology that Anil was referring to. Is that something that's going to be available across all products or it's only going to be for select products? Is it going to be an upgrade? Can you walk us through a little bit of that?

Anil Singhal

Yes. It's going to be across the entire product line and over the next 12 months. And they'll be a couple of new products, which will be – which will have the technology and it will be for the rest of the product line, which is mainly misframed. It will be available as a free upgrade for maintenance customers.

Gary Spivak – Noble Financial

Great. Thank you very much.

David Sommers

Okay. We have an operating cash flow number for the quarter. $20 million.

Operator

Okay. Your final question in queue comes from the line of Rohit Chopra with Wedbush Securities. Your line is open.

Rohit Chopra – Wedbush Securities

Thank you. I have three areas of questions. One, could you just tell us if you are getting any traction with Cisco, other than the new product, which is meant for the ISR router?

Anil Singhal

Well, we have good working relationships with a number of divisions inside Cisco. And our sales force is basically working in a positive – in a positive relationship with Cisco. But I cannot point to dollars specifically that are directly coming from that relationship today. I expect that to change as this new product is starting to get some traction. But we have a definitely improving momentum in all other aspects.

Rohit Chopra – Wedbush Securities

Okay. Other question was related to financial services. Financial services has always been fairly strong with coming back right now. Are you getting new customers in financial services or are these existing customers upgrading older equipment? Can you give me the dynamics in the financial services industry?

David Sommers

Well, as you said, Rohit, we've had good coverage of financial services for a long time and so most of our uptick in business in from existing customers. We are looking at new customer approach and adding sales people on – in new customer areas in financials. Part of what's going on is some of the financials who were troubled and merged, as we've said in the past, have been on hold as a – in terms of their new technology buying. And they have been – they have been coming back and some of the business uptick that we saw in Q4 was that. Some of the extended maintenance contracts that we talked about is that. So that's all encouraging. And it's not over, right, it's just beginning.

We do have – we are making in-roads into some new customer areas in financials, particularly in high-speed trading. And Michael made a comment about our trading and product initiative that's in the works. As an example, we gained a new customer, a significant customer, the Toronto Stock Exchange, toward the end of the year. So in the trading space where there is a new business are for us, a new need for us to attack, not just with the exchanges, but also with their trading partners, interconnect trading partners, we are gaining new customers in noticeable numbers.

Rohit Chopra – Wedbush Securities

Okay. And then my last question. I just want to come back to this. I know there's a few people who have asked this question about the spending in sales and marketing and R&D. I'm not trying to get a number. But what I'm trying to figure out is the trajectory. And I understand the first half there's more than the second half. Sales and marketing and R&D, is there one that proportionately increases more than another? I mean, is there someplace where you're focused a little bit more on? Maybe you can just elaborate on that.

David Sommers

Okay. Well, I'll try to give you some view of that. We expect that the – the principal growth is going to be in R&D. In part – now that's now headcount number, that's an expense comment. In part that is because of the high expenses that we've seen as we talked about earlier in sales already this year that had – were some unique things, that we've said also we don't expect to recur. And so those expenses will mitigate the overall expense growth in sales and marketing year-over-year, because we've already seen a significant bubble in sales and marketing expense in 2010. So what you will see principally is growth, not huge, but noticeable growth in R&D and moderated growth in sales and marketing.

Rohit Chopra – Wedbush Securities

And overall in the second half, OpEx should sort of taper off as far as its growth, right? I mean, that's the whole point about you guys getting a little bit more leverage in the model in the second half?

David Sommers

Yes, although most of the leverage, the model leverage that we're talking about, comes from revenue growth.

Rohit Chopra – Wedbush Securities

Okay.

David Sommers

Right. So most of our added operating expense, our hiring is very early in the year.

Rohit Chopra – Wedbush Securities

Okay.

David Sommers

So you won't – so the leverage that we're talking about is bookings and revenue.

Rohit Chopra – Wedbush Securities

Got it. I appreciate it. Thank you.

David Sommers

Okay, Rohit. Thank you.

Operator

As there are no further questions in the queue, I'd like to turn the call back over to Mr. Sommers for closing remarks.

David Sommers

Okay. Well, thank you all very much for coming. Good set of questions. We appreciate it. Thank you for your interest in our fiscal year and quarter, and we look forward to talking with you again in about 90 days. Have a good day.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.

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